Is Default Risk Priced in Australian Equity? Exploring the Role of the Business Cycle

Posted: 5 Feb 2012

See all articles by H. Chan

H. Chan

University of Melbourne - Department of Finance; Monash University - Department of Accounting

Robert W. Faff

University of Queensland

Paul Kofman

The University of Melbourne

Date Written: August 25, 2011

Abstract

Using an extensive Australian sample, we explore two related issues in the context of a default risk asset-pricing factor (DEF) over the business cycle: whether a DEF can explain the size premium in the three-factor Fama–French (FF) model; and whether a DEF has a separate role itself in a four-factor version of the FF model. While we find that the default factor does not explain the success of size, our evidence shows it has a complementary role to small minus big and high minus low. Notably, subgroups of test portfolios likely to seriously challenge any asset-pricing model show evidence that the four-factor model is not perfect. Finally, while we find that conditioning on the business cycle itself has little impact, when we condition on a leading indicator, it has a positive (negative) effect on the estimated default (market) risk premium.

Keywords: asset pricing, business cycle, default risk

Suggested Citation

Chan, Howard and Faff, Robert W. and Kofman, Paul, Is Default Risk Priced in Australian Equity? Exploring the Role of the Business Cycle (August 25, 2011). Australian Journal of Management, Vol. 36, No. 2, 2011 . Available at SSRN: https://ssrn.com/abstract=1998689

Howard Chan (Contact Author)

University of Melbourne - Department of Finance ( email )

Faculty of Economics and Commerce
Parkville, Victoria 3010 3010
Australia

Monash University - Department of Accounting ( email )

Building 11E
Clayton, Victoria 3800
Australia

Robert W. Faff

University of Queensland ( email )

St Lucia
Brisbane, Queensland 4072
Australia

Paul Kofman

The University of Melbourne ( email )

Faculty of Economics and Commerce
Department of Finance
Parkville, Victoria 3010
Australia
61 3 8344 3794 (Phone)

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